Introduction
When it comes to improving your business finances, sale leaseback transactions are a hidden gem. These deals involve selling a real estate property you own to a real estate investor and then leasing it back for your business through a long-term lease agreement. But here's the exciting part: there are also some advantageous tax benefits you can tap into. In this article, we'll dive into these tax considerations, with a special focus on how you can maximize your proceeds when selling leaseback properties, incorporating insights from our tax planning partner, Ben Mandel, CEO of Horizon Tax Advantage.
1031 Exchange Benefits
Let's start with the 1031 exchange. Normally, when you sell property, you will pay capital gains tax. This can be quite a substantial hit. But with a 1031 exchange, you can delay paying those taxes if you reinvest the sale proceeds in a similar property. The interesting part? You can take advantage of this benefit with sale leaseback transactions, too.
In a sale leaseback, the capital you get from selling your property doesn't need to immediately trigger a large tax bill, especially if you’ve owned your property for a long time and have a very low basis in the asset. Instead, you can use that gain to buy another property and diversify your holdings. Instead of being concentrated in your operating business and a landlord to your operating business, you can buy a different property to diversify your risk. Keep in mind, the new property needs to be of equal or greater value to qualify for the 1031 exchange benefits.
Bonus Depreciation Benefits
Now, let's talk bonus depreciation as it relates to benefits for sale leaseback acquirers. The Tax Cuts and Jobs Act established this benefit for real estate owners of certain asset types. Bonus depreciation lets you deduct a significant chunk of the property's total cost in the same year you buy it, instead of spreading it out over several years, for qualifying properties. The benefit started at 100% in 2017, dropped to 80% in 2023, and is dropping to 60% starting in 2024.
Conduct Thorough Analysis for Smart Tax Moves
Before jumping into a sale leaseback, it's wise to conduct a tax analysis with your tax advisor. This is your chance to see what kind of tax hit you might be taking and figure out if there are ways to potentially mitigate the leakage through creative structuring strategies. Here's what you should consider:
Capital Gains Tax: Find out how much capital gains tax you'd owe if you sold the property. Think about whether a 1031 exchange is a good idea to delay those taxes and if you have any preferences for what types of like-kind properties you’d want to exchange into. It is smart to work with an advisor to help you identify potential replacement properties.
Lease Terms: For businesses entering into sale leasebacks, make sure you understand the lease provisions to determine tax and accounting treatment. Consider things like how long the lease is, the rent you're paying, if there's a buyback option, and discuss these terms with your advisor and tax/accounting consultants to make sure you’re accounting for everything correctly.
As a business owner sitting on company-owned real estate, the decision to sell through a sale leaseback arrangement can be fraught with uncertainty, especially when it comes to tax implications. The good news is that you have choices. When selling a property through a sale leaseback transaction, the tax codes offer planning options that can significantly reduce out-of-pocket expenses, such as capital gains taxes. Ben Mandel, CEO of Horizon Tax Advantage, offers some great insight:
“Property owners are often surprised to learn that their tax obligation when they decide to sell may be even higher than the current 20% federal capital gains tax and the state tax rate they would also have to pay,” Mandel said. “Understanding all the options and the potential tax implications that are available in tax law when selling a property is crucial.”
Mandel continues with an illustrative example: “For instance, a California property owner who had a $10 million property with a taxable gain of $7.5 million would face $2.8 million in capital gains taxes. If they opted for a conventional sale, they would receive $2.7 million after paying off the debt and taxes. But by using the tax codes properly, the property owner was able to pay off the debt at the time of the sale, eliminate the taxes entirely, and receive $5.5 million tax-free to reinvest.”
How is this possible? Mandel explains it this way. “This outcome was achieved by coupling two different planning strategies together, both of which have been solidly entrenched in tax law for decades—a specially crafted Limited Liability Company (LLC) with charitable tax law. Doing so gave the seller multiple benefits, including lawfully reducing the taxable capital gain from 100% to 1% and receiving added tax savings while keeping full control of the sale proceeds and shielding these assets from creditors and estate taxes. In fact, this is the same strategy that Mark Zuckerberg used for his Facebook stock before it went public.”
“What taxpayers need to understand is that these laws were created by Congress to be available for us all when they are appropriately applied. They are not reserved just for billionaires.”
Conclusion
Sale leaseback deals offer businesses a creative way to monetize their assets and generate substantial arbitrage. In order to maximize the benefits, savvy owners can take advantage of perks in the tax code to defer and mitigate their tax bill. To make the most of these benefits, it's a smart move to consult with tax experts who know the ins and outs and how to best help their clients save money. They can help you make the most of these tax benefits while aligning the deal with your overall financial and business goals. So, by considering these tax tips, you can make sale leasebacks work ever greater wonders for your business and your bottom line.
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